Advantage of Cash Discounts – Business Decisions | Financial Statement Analysis

Review the data for Case 1-4, Business Decisions Using Financial Ratios, on page 62. Then, answer the following question:

Is it becoming easier for the company to meet its current debts on time and to take advantage of cash discounts? How do you know?

If we compare the data of previous years and the current period that has been presented by the Western gear then we can see that the company is able to meet its short term obligations to some extent that will support in taking the cash discount advantage. We know that the financial ratios like the current ratio and acid-test ratio reflect the liquidity of the company (Torres, 2015).

If we carefully look at the case then we can see that the company’s current ratio has been improved from 2.1 times to 2.6 times but at the same time if we look at the acid-test ratios, inventory turnover ratios, and receivables of the company then we can see that they represent reverse direction compared to the current ratio. The acid test ratio of the company shows a decreasing trend from 1.1 to 0.8 which implies that prepaid expenses have been incurred to the company as it holds a large number of inventory on its current assets.

Generally, inventories are not considered as a liquid form of current assets as it takes times to be converted into finished goods and then cash. Because of this, the company believes in selling some portion of its current assets or might increase its collection of receivables in order to get the advantage of the cash discount. The decreasing trend in the quick ratios, receivables, inventory turnover ratios reflects that the company might be exposed to the problem of debt servicing.

References

Torres, S. (2015, April 15). Financial Ratio Analysis. Retrieved from My Accounting Course: https://www.myaccountingcourse.com/financial-ratios

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